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SUSTAINABILITY MATTERS - Environmental Management in Asia© World Scientific Publishing Co. Pte. Ltd.http://www.worldscibooks.com/environsci/7901.html

July 6, 2010 15:36 9in x 6in b998-ch01 Sustainability Matters . . . FA

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A STRATEGIC ENVIRONMENTAL MANAGEMENTFRAMEWORK: EVALUATING THE PROFITABILITY

OF BEING GREEN

SCOTT VICTOR VALENTINE and VICTOR R SAVAGE

The extent to which corporate environmental governance is correlated withfinancial performance remains a topic for debate; however, consensus of opinionseems to be that there are some environmental management initiatives thatadd value to a firm’s bottom-line and other environmental managementinitiatives that adversely impact a firm’s bottom-line. This paper puts fortha new Strategic Environmental Management Framework (SEM Framework),which ties together much of the existing theory on corporate environmentalmanagement. The SEM Framework provides analysts and corporate strategistswith a conceptual model that demonstrates how various forces influencea firm’s environmental governance commitment. Factors which influence afirm’s commitment to environmental governance are extracted from the SEMFramework and employed to guide assessment of publicly available corporateenvironmental disclosures for 88 firms listed on 5 major stock market indicesin Singapore and Canada. The environmental governance commitments ofthese firms were then compared to aggregated financial performance datain order to provide the comparative data for evaluating the environmentalgovernance — financial performance relationship. The empirical research failsto confirm a significant correlation between environmental governance andfinancial performance for firms within any of the industry indices studied.Acknowledging the positive contributions that certain environmental initiativescan have on firm profitability, this paper concludes that a weak correlationbetween environmental governance and financial performance could exist;however, the correlation is not strong enough to out-weigh the other elementsthat influence a firm’s profitability. The implication of these findings for policymakers is that mechanisms other than free-market incentives are necessary ifpolicy is to guide corporations toward adopting more sustainable environmentalgovernance practices.

1. Introduction

The main intent of the empirical research presented in this paperis to contribute to efforts to clarify the extent to which improvedcorporate environmental governance supports and enhances a firm’sfinancial performance. Specifically, the research attempts to empirically

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2 Sustainability Matters: Environmental Management in Asia

measure the strength of the correlation between corporate environmentalgovernance and reported financial performance.

Existing research concerning the corporate environmental governanceand financial performance relationship has skirted the main issueby focusing on overly-narrow proxies for evaluating the corporateenvironmental governance financial performance relationship. The currentbody of research in this field supports claims that some elements ofimproved corporate environmental governance support improved financialperformance; however, a holistic link between corporate environmentalgovernance and financial performance has yet to be supported. Studies havebeen carried out which show that;

• There appears to be a link between reducing pollutant emissions andfinancial performance (King and Lenox, 2001b; Stanwick and Stanwick,1998).

• There appears to be a link between lean production (less waste) andfinancial performance (King and Lenox, 2001a; Porter and Van derLinde, 1995).

• There appears to be support for the premise that some firms adoptthe ISO14000 environmental management system to improve financialperformance (Berthelot and Coulemount, 2004).

• There appears to be a link between superior environmental governanceas perceived by independent evaluation bodies and market valuation(Connelly and Limpaphayom, 2004; Kiernan, 2001).

• There appears to be a link between significant environmental events andmarket valuation (Klassen and McLaughlin, 1996).

• Many CEO’s perceive a link between financial performance andenvironmentally-friendly technological investments and innovationstheir firms have made (Karagozoglu and Lindell, 2002).

Despite such promising indications that aspects of corporateenvironmental governance are positively related to financial performance,there is a notable absence of research to prove that a significant correlationexists between overall corporate environmental governance and financialperformance. It is posited that the reason for the dearth of such studiesstems from the complexities involved in measuring overall corporateenvironmental governance. Quantifying a firm’s corporate environmentalgovernance commitment requires identification and measurement of



A Strategic Environmental Management Framework 3

environmental initiatives related to inputs (i.e. material usage), processes(i.e. energy use, production efficiencies) and outputs (i.e. waste andemissions). This implies that a high degree of insider knowledge isrequired to understand a firm’s corporate environmental governancecommitment. In the absence of sufficient insider knowledge, assessingcorporate environmental governance poses a significant challenge.

In order to evaluate the corporate environmental governance —financial performance relationship from a macro perspective, a promisingapproach would be to develop a method to permit the analysis ofcorporate environmental governance from external sources of information.Consequently, the main conceptual goal of this paper is to develop aframework that will guide analysts in understanding the forces whichinfluence corporate environmental governance. By understanding whatcauses firms to embrace corporate environmental governance initiatives, aninterpretivist model can then be created to help analysts better evaluateinformation provided in environmental disclosures to assess corporateenvironmental governance.

This paper contributes to the body of knowledge in corporateenvironmental management from three perspectives. First, the developmentof the conceptual SEM Framework represents a first attempt at collatingexisting research to develop a model for understanding the exogenousand endogenous strategic forces which influence a firm’s environmentalgovernance policies. Second, the paper also demonstrates how the SEMFramework can be utilised to guide evaluation of corporate environmentalstrategy. This is demonstrated by using the SEM Framework to guidedevelopment of an evaluative tool for assessing the properties of a firm’senvironmental disclosures. Third, the empirical results presented in thelatter part of this paper contribute to a growing body of empiricaldata on the corporate environmental governance — financial performancerelationship. The empirical research which evaluates environmentaldisclosures and financial data from 88 firms in Singapore and Canada failsto confirm evidence of a statistically significant linkage in the corporateenvironmental governance — financial performance relationship.

2. A New Conceptual Framework

The Strategic Environment Management Framework was constructed fromprevious environmental management and environmental reporting research.




Thus, it represents a compendium of existing knowledge. As no suchframework currently exists, it is believed that the creation of the SEMFramework represents a significant contribution to corporate environmentalgovernance research from both academic and applied perspectives.

It is believed and hoped that the academic value of the SEMFramework stems from the graphic clarity with which the strategic forceswhich influence corporate environmental governance have been collated.The framework allows academic scholars to begin to consider the inter-relationships between these forces. As the empirical section of this paperwill demonstrate, by seeing these forces from a holistic perspective, abetter understanding of a firm’s environmental governance strategy canbe ascertained.

From an applied perspective, the SEM Framework represents a firstattempt to graphically organise the existing research on elements ofcorporate environmental management strategy into one cohesive model.Thus, the SEM Framework can serve as a guide map for practitioners whowish to clarify their firms environmental management strategies.

i) Developing the SEM framework

The fundamental premise upon which the SEM Framework has beenconceptualised stems from the widely recognized tenet that forcesinfluencing the development of corporate strategy are both exogenous (notwithin the control of the corporate strategist) and endogenous (within thecontrol of the corporate strategist) (Grant, 2005). As will be seen as themodel is clarified in this section, forces that influence the development ofcorporate environmental management strategies are similarly manifest inboth the exogenous and endogenous realms.

Accordingly, in conceptualising the development of a framework toaggregate these forces into one model, it was decided that the forces wouldbe best grouped according to the extent of control that strategist had overthe forces- working from exogenous to endogenous realms. The frameworkis presented in Fig. 1.1 with the realms summarised below:

• The first realm of influential forces are those broad forces that occur inthe macro-economic environment. Unsurprisingly, these forces are alsoforces which the corporate strategist has the least control over.

• The second realm of forces are the forces that arise through the efforts ofsecondary stakeholders (community members, interest groups etc.). The




Fig. 1.1. The strategic environmental management framework.

strategist may be able but manipulate these forces; but by and large,these forces are also exogenous to firm control.

• The third realm of forces are industry-specific forces. Since firms havethe ability to adjust strategy to enter and exit market niches, there isa degree of strategic control implied when strategists consider how torespond to these forces.

• The fourth realm of forces are firm-specific forces. These forces arepredominantly structural in nature and as such can be manipulated bythe firm. However, the structural foundation of these forces implies thatmanipulation of these forces does not come without significant strategicrepositioning and organisational re-engineering.

• The final realm of forces are those which are endogenous and strategic innature. In short, this final strategic realm is the realm within which mostcorporate environmental management currently takes place becausethese elements are strategically controllable.

In subsequent paragraphs these five realms will be clarified withexamples from prominent extant research which exists in each realm.




Furthermore, an intuitive review of the impact that the forces from eachrealm should have on environmental reporting will be provided in order toguide conceptual development of an analytical tool that will be used laterin the paper for conducting the empirical research.

ii) Realm 1- macro forces

Macro forces are the broadest forces that influence how a firm approachesenvironmental management. In strategic management theory, theseforces are referred to as PEST forces: Political, Economic, Social andTechnological (Grant, 2005). The tenet is that the PEST forces in eachcountry influence the extent to which firms within industries approachenvironmental governance (Kolk, 2005).

Macro forces act as “expectation dampeners”. The macro forceswhich influence an industry frame the degree of environmental governancethat stakeholders expect of a firm. A comparison between macro forcesinfluencing corporate environmental governance in China and Canadais insightful as an example. In China, civic reaction to poor corporateenvironmental governance is less intense for a number of macro reasons(Iu and Batten, 2001). Economically, the country is in the throes of aneconomic boom and; therefore, sustaining economic growth is driving publicpolicy. Although there are recent indications of change,1 economic growthcurrently takes precedence over environmental protection. Moreover, as theTiananmen Square protests of 1989 exemplify, the Chinese government doesnot respond well to unauthorised mass public protest. On the other hand,in Canada, civic reaction to poor corporate environmental governance isrelatively more robust because the environmental watchdog communityis well-established and has better access to communication networks tovoice dissent. Moreover, Canadian citizens are comparatively more affluentso they exhibit a higher propensity to accept higher taxes to facilitateimproved environmental policies (Costanza et al., 1997). In short, it can beconcluded that environmental governance expectations are currently higherin Canada than in China because of the macro forces which act on society(Kolk, Walhain and Wateringen, 2001). In summary, macro forces influencethe environmental governance contributions expected of corporations and

1For example, China now boasts the second largest number of ISO14000 certified firmsin the world.




therefore, frame the lower limits of environmental disclosure done in acountry (Kolk, 2005).

iii) Realm 2- secondary stakeholder forces

A significant amount of research has emerged over the past decade insupport of the contention that firms must balance strategic objectives toensure that a broad spectrum of stakeholders’ expectations are adequatelysatisfied (Neely, Adams and Kennerley, 2002; Kaplan and Norton, 1996).Secondary stakeholders may have less direct contact with a given firm; butnevertheless, they possess formidable power in influencing the fortunes ofthe firm. Six secondary stakeholder groups which have been identified inprevious research as having a particularly strong influence on how a firmapproaches environmental governance include:

• Creditors (See for example: Deegan, 2002; Wilmshurst and Frost, 2000).• Government Regulators (See for example: Yakhou and Dorweiler, 2004;

Patten, 1992).• Interest Groups (See for example: Adams, 2004; Wilmshurst and Frost,

2000).• General public (See for example: Van Tulder, 2005; Cormier and

Magnan, 2003).• Educators (See for example: Russell, 2006; Cormier, Gordon and

Magnan, 2004).• Unions (See for example: Van Tulder, 2005).

Secondary stakeholders represent significant threats to firms in regardto environmental governance issues (Khanna, 2005). Lenders and borrowerswho are displeased with a firm’s environmental stewardship can punishthe firm by denying the firm access to funding (Wilmshurst and Frost,2000). Government regulators who are displeased can impose stricterregulations, levy financial penalties, and even force businesses to close(Beets and Souther, 1999). Union displeasure can result in plant closures.Most significantly, public pressure and pressure from watchdog groupscan severely impact the market viability of a firm’s product offerings(Van Tulder, 2005; Carter, 2001). Accordingly, given the severity ofthese threats, firms are motivated to embrace stakeholder theory andensure that secondary stakeholder expectations are, at a minimum,satisfied.




In environmental reporting, signals that a firm is attemptingto appease secondary stakeholders are indicated through qualitativeexhortations which seek to positively laud isolated but comparatively minorenvironmental achievements. This type of reporting is the realm withinwhich legitimization attempts would most likely occur. It is also the mostunreliable area in which to judge actual corporate performance becausefirms that subjectively claim a commitment to superior environmentalmanagement may or may not be committed to such goals behind corporatedoors.

iv) Realm 3- industry-specific forces

In 1980, Michael Porter, an authority on corporate strategy introduced his5 Forces framework which demonstrated how forces in a firm’s industryinfluence the attractiveness of the industry and define the parameterswithin which firms in the industry must operate if they are to succeedin the long run (Porter, 1980). Since industry forces influence overallstrategy, it should come as no surprise that industry-specific factors relatedto environmental governance also impact a firm’s environmental strategy.Research has identified six groupings of industry-specific forces that impactthe extent to which firms embrace environmental governance initiatives.Previous research has identified the following elements of industry structureas influencing corporate-level environmental governance:

• Types of Industry (See for example: Shirley, 2005; Campbell, 2003).• Risks associated with specific industry tasks (See for example: Cormier,

Gordon and Magnan, 2004; Cerin, 2002).• Media exposure (See for example: Adams, 2004; Cormier et al., 2004).• Customer (buyer) pressure (See for example: Kolk, Walhain and

Wateringen, 2001; Wilmshurst and Frost, 2000).• Supplier (vendor) incentives (See for example: Wilmshurst and Frost,

2000).• Industry business practice (See for example: Kolk, 2005; Deegan, 2002).

Overall, industry-specific forces have the capacity to either raise the barin terms of corporate environmental governance in an industry or dampenprogress. At the end of the day, a firm’s continued viability is directly relatedto its ability to compete successfully with rival firms and to profit in doingso (Porter, 1980). Consequently, when it comes to industry best practice,




there is a tendency for firms to adopt a herding mentality. For this reason,comparison of corporate environmental practices in firms from differentindustries should be undertaken with the knowledge that an industry-type will impact the extent of commitment to corporate environmentalgovernance.

In environmental reporting, the presence of industry-specific forces willoften induce similar reporting patterns for firms from similar industries.In fact, it would not be unreasonable to assume that environmental reportwriters at one firm use the disclosures of competing rivals as benchmarksto guide the presentation of content in their own firm’s environmentaldisclosures. Therefore, when analyzing environmental disclosures, analystsshould be aware of the possibility that disclosures which seem on the surfaceto be of superior quality may, in fact, simply be a product of commonpractice within the industry.

v) Realm 4- firm-specific forces

Firm-specific forces can be defined as influences on corporate environmentalgovernance that are related to the unique structure of a given firm. Inparticular, the type of ownership and characteristics associated with thefirm’s asset base influence the extent to which firms can financially supportenvironmental governance initiatives beyond those initiatives that actuallyproduce positive returns to the firm. For example, firms that are facing cashflow constraints and which possess an ageing asset base are in a less viableposition to upgrade to new technologies that would reduce pollution andwaste levels. There are five main firm-specific structural characteristics thathave been identified in the literature as influencing how a firm approachescorporate governance.

• Ownership characteristics (See for example: Cormier and Magnan, 2003;Cormier and Gordon, 2001).

• Firm size (See for example: Cormier and Gordon, 2001; Kolk, Walhainand Wateringen, 2001).

• Financial health (See for example: Cormier, Gordon and Magnan, 2004;US EPA, 2000).

• Age of assets (See for example: Cormier, Gordon and Magnan, 2004).• Environmental reputation (See for example: Cerin, 2002; Patten, 1992).

Two observations concerning the influence that firm-specific forceshave on corporate environmental governance are worth highlighting.




First, similar to the impact that macro forces have on corporateenvironmental governance, firm-specific forces act as constraints tocorporate environmental governance. This characteristic is important tounderstand because it implies that all firms do not share the same capacityto commit to superior environmental governance practices. Larger firmswith a more concentrated ownership base, newer assets and healthy levels ofcash flow should be financially able to adopt more proactive environmentalstewardship strategies.

Second, firm-specific forces represent the only cluster of forces that canbe assessed through quantitative analysis of a firm’s financial statements.The breadth of the ownership base, the relative size of the firm, a firm’sfinancial health and the age of assets can all be determined throughquantitative financial statement analysis.

Thus, knowledge of a firm’s structure can play an influential role ininterpreting a firm’s commitment to corporate environmental governance.Quantitative analysis of financial reports can identify constraints if any,that a firm is facing which would limit its ability to adopt more proactiveenvironmental management strategies. Overall, analyzing a firm’s capitalstructure (ownership, size, past profitability, cash flow, age of assets etc.)can tell an analyst what upper limits to environmental governance can beexpected to emerge in environmental disclosure.

vi) Realm 5- strategic forces

Strategic forces represent the activities that firms undertake in theenvironmental governance sphere which directly impact a firm’s marketvaluation, revenue prospects or cost performance in either the short or longterm. These forces stem from the principle of “economic rationality”- firmswill adopt environmental management practices that contribute positivelyto a firm’s financial health (Deegan, 2002; p. 290).

The ability to strategically manipulate these forces underlie thefoundation of Porter’s Hypothesis (Porter and Van der Linde, 1995).Previous research have identified the following areas where issues relatedto environmental governance can be strategically managed:

• Green positioning strategies (See for example: Kiernan, 2001; Hawken,1992).

• Financial strategies (See for example: Khanna, 2005; Beets and Souther,1999).




• Brand Protection strategies (See for example: Ruf et al., 2001; Kolk,Walhain and Wateringen, 2001).

• Quality strategy (See for example: Stanwick and Stanwick, 2001; Berryand Rondinelli, 1998).

• Cost-control strategies (See for example: Adams, 2004; Porter and Vander Linde, 1995).

In environmental reporting, strategic environmental initiatives areoften highlighted in order to convey the message to shareholders andstakeholders alike that the firm is achieving balance between environmentalresponsibility and profitability. For example, in Xerox’s 2005 EnvironmentHealth and Safety Report, quantitative data is provided which illustratesprogress over the previous year in reducing the firm’s ecological footprint.However, in the same document, Xerox also draws attention to the fact thatits improved environmental governance efforts also resulted in significantcost savings to the firm.

vii) Pulling the elements together

Systems which are comprised of numerous elements that are inter-relatedand that themselves are constantly evolving are known as complex adaptivesystems (Brown and Eisenhardt, 1997). As the name implies, the maindistinguishing characteristics of a complex adaptive system (CAS) arethe complexity of interrelationships that impact the evolution of thesystem and the dynamic nature of the system’s components which resultsin goal posts that are constantly moving (Stacey, 1995). As shouldbe evident at this point in the paper, the forces discussed in thispaper which influence a firm’s environmental governance strategy andenvironmental disclosures should be considered collectively as elementswithin a CAS. Thus, the SEM Framework which was presented in Fig. 1.1represents an attempt to visualize this complex CAS in a clear conceptualframework.

Extrapolating from the observations made earlier regarding how eachof the five groupings of forces identified in the SEM framework influenceenvironmental disclosure, a conceptual model can be derived to demonstratehow the strength of a given firm’s commitment to environmental governancestrategy relates to the type of environmental disclosure it makes.

Figure 1.2 illustrates that semantic patterns in environmental disclos-ures can be used to approximate a firm’s commitment to environmental




Fig. 1.2. Strategic commitment to environmental governance and the relationship toenvironmental disclosure.

governance. Specifically, working left to right along the spectrum:

• The presence of quantitative environmental performance data inenvironmental disclosures indicates that not only has a firm thoughtdeeply about environmental governance policy, but it has alsoestablished systems and structures to monitor commitment. Such firmscan be considered as highly committed to corporate environmentalgovernance strategy.

• Less committed, but still strategically superior firms can be identifiedby a commitment to maintain internationally certified environmentalmanagement systems (EMS) such as ISO14000 or EMAS. Thesestandards commit the organization to a process of formally adoptingthe processes and structures necessary to receive external certification.Although these standards do not commit firms to specific environmentalperformance standards, these independently-verified environmentalmanagement systems are representative of a high level of formalizedcommitment to improving corporate environmental governance (Kingand Lenox, 2005).

• References in environmental disclosures to the adoption of in-houseEMS are indicative of firms that are showing signs of adoptingmore sophisticated strategic environmental governance policies. Thedisparate nature of in-house EMS imply that these firms may not beas strongly committed to improved environmental governance as firms




with ISO14000 or EMAS certification; however, in-house EMS regardlessof their scope, take time and effort to develop. Accordingly, such firmsshould be considered to be above average in terms of commitment toenvironmental governance.

• Similarly, firms which produce stand-alone environmental reportsshould be considered to be above average in terms of commitmentto environmental governance practices. Although for some firms, theproduction of stand-alone environmental reports may be partly amarketing exercise (Cerin, 2002); creating a stand-alone document thatwill be vetted by external stakeholders requires significant considerationof environmental issues.

• The level of commitment to environmental governance strategy forfirms that limit public disclosure of environmental governance toenvironmental policy statements published on corporate web-sites orin corporate public disclosures is difficult to assess. Such policystatements may in fact guide concrete environmental initiatives butpolicy statements may also simply be attempts to legitimize a firm’senvironmental governance to external stakeholders. Accordingly, in theabsence of specific examples of environmental initiatives to supportthe policy claims, these types of statements should be consideredas extemporaneous legitimization efforts because stakeholder theoryand legitimacy theory imply that firms which can publicly laudenvironmental governance achievements will do so.

• Finally, in some Annual Reports, firms that do not have astrong commitment to environmental governance may present vague,qualitative exhortations which declare a concern for the environmentand the corporate intent to be responsible corporate citizens. Again, inthe absence of specific examples of environmental initiatives to supportthese declared intentions, such statements should be considered aslegitimization efforts which lack substance.

With a clearer conceptual understanding of how the five realmsof Strategic environmental management forces influence the nature ofcorporate environmental disclosure, we can now turn to the empiricalresearch.

3. Research Objective and Methodology

The main premise of the empirical study presented here is to testthe strength of the corporate environmental governance — financial




performance relationship. Formally stated, the central hypothesis isaffirmatively stated as follows:

A significant positive correlation exists between a firm’s commitment tocorporate environmental governance and its financial performance.

Prior to selecting subjects for inclusion into the research project,it is necessary to establish two baseline standards to operationalisethe variables. First, a standard for measuring a firm’s commitmentto corporate environmental governance through the interpretation ofenvironmental disclosures must be determined. Second, a standard or set ofstandards for measuring a firm’s financial performance must be established.Standardizing measures in these two areas will enable comparison of firmsto establish relative performance.

i) Baseline standards for measuring environmental

performance

As per the conceptual foundation outlined in Fig. 1.2, strategic commitmentto environmental governance can be measured on a scale from deep toshallow commitment and this commitment can be assessed by analyzingthe contents of environmental disclosures. The presence of quantitativeenvironmental benchmarks or other environmental performance datareflects a firm with a comparatively deep commitment to environmentalgovernance. At the other extreme, the presence of unqualified environmentalexhortations in environmental disclosures is indicative that a firm’scommitment to environmental governance is more style than substance- itis trying to legitimize a largely ambivalent commitment to environmentalgovernance. This conceptual understanding permits the creation ofstandardized measures.

Table 1.1 demonstrates that conceptual knowledge of how environ-mental governance strategy and environmental disclosure interact permitthe development of operational measures that can be applied toenvironmental disclosure analysis in order to interpret a firm’s commitmentto environmental governance. The five levels of commitment identified inTable 1.1 represent the standards by which the firms in this researchstudy will be measured to evaluate commitment to corporate environmentalgovernance. The deepest form of commitment to environmental governanceis represented by Level 1- Leaders. Similarly, the weakest form ofcommitment is represented by Level 5- Avoiders.




Table 1.1. Standards for measuring environmental governance.

Level 1- LeadersAre defined as . . .

• Firms committed to setting quantitative benchmarks in environmental initiatives.Which appears in environmental reporting as . . .

• Quantitative progress indicators related to environmental initiatives.Level 2- ContendersAre defined as . . .

• Firms which have adopted externally accredited environmental managementsystems.

Which appears in environmental reporting as . . .• Specific reference made to ISO14000 or EMAS accreditation.

Level 3- TalkersAre defined as . . .

• Firms that are currently experimenting with the effectiveness of environmentalmanagement initiatives.

Which appears in environmental reporting as . . .• Qualitative stand-alone environmental reports.

Level 4- PretendersAre defined as . . .

• Firms that understand the threat posed by poor environment governance. Thesefirms therefore, endeavour to demonstrate that they meet all binding regulations.

Which appears in environmental reporting as . . .• Qualitative environmental disclosure over 50 words amidst Annual Reports or on

web-sites.Level 5- Avoiders

Are defined as . . .• Firms that obey environmental regulations because they must. However, they do

not see a need to strategically address any environmental issues.Which appears in environmental reporting as . . .

• Empty space. Firms classified as Avoiders do not disclose any information onenvironmental issues.

ii) Baseline standards for measuring financial performance

There has been considerable debate over which financial metrics shouldbe used for judging the competitive performance of a firm (Ruf et al.,2001). For the purposes of this study, four metrics have been establishedas collective indicators of financial health: 1) % change in sales volume, 2)Profit margin, 3) Return on equity and 4) Return of assets.

The justification for using these four metrics as financial performancemeasures is largely provided by Ruf et al. (2001). Growth in sales wasselected because of the significant role it plays both in strategy formulationand in investment valuation models. Moreover, sales growth is not as proneto the criticisms often applied to return on investment measures that such




measures can be manipulated by accountants (Ruf et al., 2001). Profitmargin represents the most commonly referenced measure of a firm’s overalloperating effectiveness. Return on equity was selected because it is theprimary measure of evaluating profitability from an investor’s perspective(McLaney and Atrill, 2002) and return of assets was selected because itprovides a measure of profitability that aggregates both equity and debtsources of capital. It is conceivable for all four measures to vary from oneanother.2 Therefore, in order to leverage the benefits of each of the fourmeasures while concurrently avoiding the disadvantages associated withthe specialised perspectives on financial performance that each measurerepresents, it was deemed that an equally-weighted aggregate of all fourmeasures would be used to evaluate financial performance.

It was decided to use corporate annual reports as the basis from whichto gather audited data related to financial performance. On the other hand,data related to public disclosure of environmental governance initiativeswere gathered from three sources: (1) corporate annual reports, (2) stand-alone environmental reports if available on a given firm’s web-site and(3) information on environmental activities presented on the web-sites ofthe subject firms. Campbell (2003) confirms that for the sake of assessingpublic disclosure strategy, annual reports and other documents availableon corporate internet sites can provide sufficient information for assessinga firm’s social reporting practices.

The target firms selected for inclusion in the study came from twogeographically-defined sources. Group 1 firms were all from Singapore.Firms from one country were analyzed together in order to eliminatethe disparate influences on corporate environmental governance activitiescaused by macro forces and secondary forces as described in the ELFconceptual framework. Singapore was chosen as the target country forGroup 1 firms because its political environment “constrains citizendemands for information and minimizes regulatory pressure on companies”(Perry and Sheng, 1999: 310). In other words, secondary stakeholderinfluence is comparatively light in Singapore. Accordingly, it wasanticipated that firms from Singapore will have a lower propensity toproduce environmental disclosures that attempt to legitimize environmentalgovernance performance.

2In fact the data from the empirical study bears witness to the validity of this claim.Many firms in this study reported disparate performance in the four areas of financialmeasurement.




Group 2 firms were all from Canada. Once again, the rationale forgrouping firms from one country together was to reduce environmentalreporting distortions caused by macro and secondary forces. Canada andSingapore have similar levels of affluence in terms of per capita GDPand both countries are Commonwealth nations so political structures aresimilar. Therefore, the allure of choosing Canada as a foil to Singapore isthat the similarities permit comparison of whether or not the comparablyhigher presence of environmental watchdog groups in Canada (Perry andSheng, 1999) influence environmental governance.

In total there were 88 firms chosen for the study: 60 firms fromSingapore and 28 firms from Canada.

In order to isolate industry-specific forces which influ-ence environmental governance (as outlined in the ELF framework), itwas decided to select target firms from common industry groupings.Two environmentally-sensitive industrial groupings were selected becauseprevious studies indicate that environmental governance and environmentaldisclosure will be most robust in environmentally-sensitive industries(Shirley, 2005; Campbell, 2003; Deegan and Gordon, 1996). The two broadindustrial areas selected were (1) construction/industrial production and(2) transport, shipping and telecommunications.

In order to try and minimize distortions caused by disparate sized firms(a concern identified in the SEM framework), all the firms chosen for thestudy were leaders in their respective fields. In order to determine whichfirms were recognized as industry leaders, all the firms selected for the studywere part of stock market industry indexes.

In summary, the firms chosen for the empirical study included:

• All the firms comprising the Singapore Stock Exchange ConstructionIndex (20 firms in total).

• All the firms comprising the Singapore Stock Exchange Transport,Shipping and Telecommunications Index (29 firms in total).

• All the firms comprising the Toronto Stock Exchange Industrials Index(22 firms in total).

• All the firms comprising the Toronto Stock Exchange Tele-communications Index (6 firms in total).

In total, this represents 77 of the 88 firms included in the study. Theother 11 firms were all firms comprising the Singapore Stock ExchangesHotels Index (11 companies). They were included to provide a reference




benchmark for service industry firms. It was felt that earmarking amajor service industry as a reference benchmark would provide anopportunity to compare correlation results in order to determine whetheror not environmental-sensitivity in a given industry truly does influenceenvironmental disclosure.

As a first step, after reviewing all the publicly available informationfrom 2002 relating to environmental activities,3 each firm was classifiedinto one of the five environmental governance levels outlined earlier:

• L1 =Leaders (quantitative data on corporate environmental gover-nance).

• L2 =Contenders (adoption of ISO14000 or EMAS).• L3 =Talkers (publishing stand-alone environmental reports).• L4 =Pretenders (producing qualitative environmental discourse of over

50 words).• L5 =Avoiders (making no public mention of environmental activities).

For each firm, the highest level of environmental governancecommitment identified through environmental reporting analysis wasregarded as the defining level for that firm. For example, if a firm publisheda stand-alone environmental report (L3), was ISO14000 accredited (L2)and included quantitative data on corporate environmental governance inits stand-alone environmental report (L1), it was listed as an L1 firm.

Next, total revenue and operating profit data were extracted fromaudited Income Statements for years 2002–2005 in order for sales growth4

and profit margin5 statistics to be determined. Furthermore, total assetsand total equity data for 2003–2005 were extracted from the audited balancesheets of each firm in order to calculate return on equity6 and return onasset7 data.

For each year, averages for all the firms within a given index werecalculated for sales growth, profit margin, return on equity, and return

32002 public disclosures were used for this process in order to link environmentalreporting to future financial performance. Financial data from 2002–2005 were usedfor this purpose.4Sales Growth = (Current year revenues — Previous year revenues)/Previous yearrevenues.5Profit Margin= Operating Profit/Total Revenue.6Return on Equity = Operating Profit/Total Shareholder Equity (including reserves).7Return on Assets = Operating Profit/Total Assets.




on assets. A smoothing methodology was used to calculate these averages.In the smoothed average approach, 10% of the firms exhibiting the mostextreme performance variances (either above or below industry average)were removed from the pool before the industry average was calculated.This was done separately for the Singapore Stock Exchange ConstructionIndex firms, the Singapore Stock Exchange Transport, Shipping andCommunications Index firms, the Singapore Stock Exchange Hotel Indexfirms, the Toronto Stock Exchange Industrials Index firms, and the TorontoStock Exchange Telecommunications Index firms.

Once smoothed averages for the firms in each of the five index categorieswere calculated, the performance of each firm was then compared to thesmoothed index average in the respective indices. This facilitated theidentification of firms that outperformed the average for each financialperformance metric used.

The number of times each respective firm outperformed the industryaverage (within the 12 performance metrics) along with the firm’senvironmental management commitment rating (L1 to L5) were thenplotted through correlation analysis in order to determine if there wascorrelation between environmental commitment and financial performanceeither in the base year or in two subsequent years. Trend analysisthat included identification of the coefficient of determination (r2) wasapplied to each of the five indices in order to assess the strength ofcorrelation between corporate environmental governance and financialperformance.8

4. Results of the Environmental Reporting Comparison

A) Singapore

As Fig. 1.3 outlines, only 17% of the Singapore firms included in thestudy disclosed information on environmental activities in a public mannerand only 14% could be considered substantive reporters (L1 and L2)of environmental initiatives. This parallels findings in a 2002 surveyof environmental reporting conducted by ACCA-Singapore which foundthat only 10% of the Singaporean firms surveyed produced substantiveenvironmental disclosures (ACCA, 2005a).

8In this instance, r-squared represents the fraction of variability in financial performancethat is attributable to a firms level of environmental governance (L1 to L5).




Singapore Firms

2% 12%0%

83%

3%

L1- Leaders

L2- Contenders

L3- Talkers

L4- Pretenders

L5- Avoiders

Fig. 1.3. Percentage of singaporean firms falling within each L-classification.

Some specific points relevant to the findings from Singaporean(Group 1) firms include:

• There was only one “L1-Leader” (Singapore Airlines) which producedan environmental report with quantitative data.

• Six firms were classified as “L2-Contenders” on the basis of ISO14000certification.

• There were no “L3-Talkers”, because the only firm that produced astand-alone report (Singapore Airlines) was also ISO14000 certified(classifying it as a L2 firm) and included quantitative data in itsenvironmental disclosure (classifying it as an L1 firm). As stated earlier,the end rating assigned to each firm was based on the highest attainmentachieved on the L1-L5 scale.

• Only two firms (CWT and SMRT Corporation) were classified as “L4-Pretenders”. These two companies made qualitative mention of theirintention to operate in an environmentally responsible manner. However,the disclosures failed to identify any significant initiatives designed tosupport such a quest.

• None of 11 Singapore hotels included in the survey provided corporateenvironmental disclosure of any type. They were all “L5-Avoiders”. It islikely that this reflects the underlying mind-set of many service industryfirms that their ecological impact is negligible and that, therefore, thereis no need to report on environmental governance (Cerin, 2002).

Overall, the results of the research support previous findings thatenvironmental initiatives in Singapore are, by and large, limited to




Canada Firms

18%

11%

0%57%

14%

L1- Leaders

L2- Contenders

L3- Talkers

L4- Pretenders

L5- Avoiders

Fig. 1.4. Percentage of canadian firms falling within each L-classification.

compliance initiatives (Perry and Sheng, 1999); and consequently, corporatereporting in also limited (ACCA, 2005).

B) Canada

As Fig. 1.4 indicates, 43% of the Canadian firms included in the researchstudy provided public disclosures concerning environmental activities.Although this appears to be considerably superior to the percentage of firmsin the Singapore group that produce environmental disclosures (17%), ifthe L4-Pretenders (firms which produce disclosures that are not supportedby substantive examples) are factored out, the ratio of firms that providesubstantive reporting (L1-Leaders and L2-Contenders only) narrows to 29%for the Canadian firms and 14% for the Singaporean firms.

Some specific points relevant to the Canadian findings include:

• Of the five “L1-Leaders” which produced an environmental reportwith quantitative data, only two were ISO14000 certified. In otherwords, the other three generated quantitative reports based on in-houseenvironmental management systems. This supports previous researchwhich states that in-house Environmental Management Systems (EMS)are as prevalent as ISO14000-based EMS in North America (Berthelotand Coulmont, 2004).

• The three firms that were classified as “L2-Contenders” on thebasis of ISO14000 certification, included Bombardier (the airplanemanufacturer), Finning (the sales agent for Caterpillar tractors) andQuebecor (the global printing company). These three firms have likelysought ISO14000 certification because they operate in internationalmarkets where ISO14000 certification is a competitive strength.




• As with the Singapore cluster of firms, there were no “L3-Talkers”in the Canadian cluster because the three firms that produced stand-alone environmental reports (CN Rail, Bell Canada-BCE and ManitobaTelecom) also included quantitative data in their environmentaldisclosures (classifying them as L1 firms).

• There were four firms classified as “L4- Pretenders”. These companiespublicised policy statements that they intended to operate in anenvironmentally responsible manner. However, the disclosures failed tosupport these exhortations with examples of supporting initiatives. It ispossible that there were twice as many Pretenders in Canada as therewere in the Singapore study because leaders of Canadian firm’s deemit necessary to legitimize their environmental governance efforts dueto pressure from numerous environmental watchdog organizations inCanada.

Contextual inferences

The data presented above, cannot be used as a proxy to represent the overalllevel of reporting undertaken in Canada or Singapore. This is because thescope of the firms included in the research sample was not representativeof the entire scope of business in each respective country.9 As was pointedout during the development of the SEM Framework, factors such as firmsize, financial health and industry type play roles in influencing the extentto which firms commit to environmental governance. In the case of thefirms included in this study, the firms were all market leaders in theirrespective industries. As a result, they were all comparatively larger thanmost rival firms and in comparably better financial health because theequity shares of the firms were included on major indices which attractfunds more easily. Furthermore, these firms were from the same industries;therefore, extending the results to firms from other industries would likelyresult in attribution errors (Shirley, 2005).

The true value of the data presented above is to provide a contextualbackground to the reporting done by firms in Singapore and Canada. Giventhat substantive environment reporting (L1-Leaders and L2-Contenders)was significantly higher concerning the Canadian firms (29%) than the

9Note- It was not the intention of this paper to undertake a study of broader scope. Themain thrust of this paper is to test the corporate environmental governance — financialperformance link; therefore, limiting the scope of the study was necessary in order toeliminate industry distortions.




Singaporean firms (14%), there are reasons to conclude that Canadianfirms have a greater propensity to disclose environmental governance issueswhen compared with Singaporean firms. What the exact ratio is betweenfirms releasing environmental reports in Singapore and firms releasingenvironmental reports in Canada would require a study of much broaderscale and scope. For the purposes of this study it is merely of importance tounderstand that more Canadian firms report on environmental issues thancompared to Singaporean firms.

The reason that this knowledge is of contextual importance tothe study relates to the findings regarding the correlation betweenenvironmental governance and financial performance. If a significantpositive correlation is identified, the observation that more Canadianfirm’s produce environmental reports implies that Canadian businessesmight better understand the link between environmental governance andfinancial performance. In other words, more education would be necessaryin Singapore to enlighten Singaporean businesses about the link betweenenvironmental governance and financial performance.

Evaluating the environmental governance-financial performancecorrelation.

The Y -Axis represents the percentage of financial indicatorsoutperforming the industry average (aggregate total of the index firms).The 12 financial indicators include:

• 2003 Return of Equity, 2004 Return of Equity, 2005 Return of Equity.• 2003 Return of Assets, 2004 Return of Assets, 2005 Return of Assets.• 2003 Revenue Growth, 2004 Revenue Growth, 2005 Revenue Growth.• 2003 Profit Margin, 2004 Profit Margin, 2005 Profit Margin.

For example, if a firm’s performance in 2003 exceeded the industryaverage in Return on Equity and Profit Margin, its performance in 2004exceeded the industry average in Return on Assets, and in 2005 it didnot exceed the industry average on any of the 4 financial standards, thenits total would be 3 indicators exceeded out of 12. Accordingly the Y -Axis measure would be 25%.10 Three years of financial data following theenvironmental reports of 2002 were selected to ensure that the impacts

10It should be noted that for a handful of firms, data was not available for certain years.In these cases, the denominator for calculating the Y -Axis percentage was adjustedaccordingly.




Singapore SECONS Indexy = 0.0262x + 0.2809

R2 = 0.0095

0%10%20%30%40%50%60%70%80%

0 1 2 3 4 5 6

Environmental Commitment (L1 to L5)

% o

f in

dic

ato

rs

outp

erf

orm

ing industr

y

avera

ge

Fig. 1.5. The environmental commitment-financial performance link for Singaporeexchange construction (SECONS) Firms.

of the environmental initiaitives were incorporated into the financialperformance of the firms.

Singapore exchange construction index

Upon first glance, the upward sloping trend line in Figure x could beinterpreted to mean that superior corporate environmental governancegives rise to inferior financial performance for firms in the SECONS index.However, with an R2 value of 0.0095, it can be concluded that no significantcorrelation is evident between corporate environmental governance andfinancial performance for the firms studied in the Singapore exchangeconstruction index.

Both of the ISO14000 accredited firms (L2) underperformed in over halfof the financial indicators when compared to index financial performanceaverages.

Singapore exchange transport, shipping and communications index

As a visual fit purview of Fig. 1.6 indicates, there is a significant correlationbetween environmental governance commitment and financial performanceis not evident for the 29 firms included in Singapore’s Transportation,Shipping and Communications Index. Mathematically, an R2 value of0.0015 confirms this assertion.

Of particular interest, the firm with the best overall commitmentto environmental management initiatives (Singapore Airlines) performedbelow the financial performance index averages 80% of the time.




Singapore SETSC Indexy = -0.0082x + 0.5005

R2 = 0.0015

0%

20%

40%

60%

80%

100%

120%

0 1 2 3 4 5 6


% o

f in

dic

ato

rs

outp

erf

orm

ing industr

y

avera

ge

Fig. 1.6. The environmental commitment-financial performance link for Singaporeexchange transport, shipping and communication (SETSC) Firms.

Singapore SEHOT Index

0%

20%

40%

60%

80%

100%

0 1 2 3 4 5


% o

f in

dic

ato

rs

outp

erf

orm

ing industr

y

avera

ge

6

Fig. 1.7. The environmental commitment-financial performance link for Singaporeexchange hotels index (SEHOT) firms.

Singapore exchange hotels index

Given that none the 11 firms included in Singapore’s Hotels Index publishedenvironmental disclosures, creating a trend line was not possible. Figure 1.7shows the dispersion of corporate data. With no disparate corporateenvironmental governance standards for comparison, a correlation betweenenvironmental commitment and financial performance could not beassessed.




Toronto TSXIND Indexy = 0.0713x + 0.2345

R2 = 0.0956

0%

20%

40%

60%

80%

100%

120%

0 1 2 3 4 5 6


% o

f in

dic

ato

rso

utp

erf

orm

ing

in

du

str

yavera

ge

Fig. 1.8. The environmental commitment-financial performance link for toronto stockexchange industrial (TSXIND) firms.

Toronto exchange industrials index

The trend line in Fig. 1.8 also implies at first glance that aninverse correlation exists between corporate environmental governance andfinancial performance for the 22 firms included in the Toronto StockExchange Industrials Index. Although the R2 value for the TSXIND firmsof 0.0956 represents the highest correlation of all the five index correlationstudies, the value is still too low to conclude that a significant correlationexists between the variables.

It is worth highlighting that the firms in Fig. 1.8 which producedquantitative corporate environmental governance measures (L1) andISO14000 accredited firms (L2) achieved widely disparate financialperformance results. Two firms in these two groupings (L1 and L2) reportedfinancial performance which exceeded the index average in over 75% ofthe financial performance markers; however, 3 firms reported financialperformance which fell below the index average in over 80% of the financialperformance markers.

Toronto exchange telecommunications index

Unsurprisingly given the results from the other indices, evaluating the6 firms listed in the Toronto Stock Exchange Telecommunications Indexalso produced evidence of no significant correlation between environmentalcommitment and financial performance (Fig. 1.8). Mathematically, the R2

value of 0.002 supports this conclusion. Although the sample size was too




Toronto TSXTEL Indexy = -0.0069x + 0.4792

R2 = 0.002

0%

20%

40%

60%

80%

100%

0 1 2 3 4 5 6


% o

f in

dic

ato

rso

utp

erf

orm

ing

in

du

str

yavera

ge

Fig. 1.9. The environmental commitment-financial performance link for toronto stockexchange telecommunications (TSXTEL) firms.

small for statistical reliability, the data strongly implies that other forcesappear to influence financial performance to a far greater extent thancorporate environmental governance does.

Based on the results of the research, it is valid to conclude that for thefirms included in the indices researched in this report, no significant positivecorrelation can be proven between corporate environmental governance andfinancial performance over the range of years covered in this research study(2003–2005). Therefore, results from the research do not support the centralhypothesis.

It should be noted that failure to confirm the central hypothesisdoes not necessarily mean that environmental commitment has no impacton financial performance. It does appear from the research study thatthere are other more significant influences on financial performance thatrender overall environmental governance commitment negligible in termsof influencing financial performance.

This interpretative conclusion is supported by the observation that theresearch findings also indicate that no significant negative correlation existsbetween corporate environmental governance and financial performance.If the abundance of anecdotal research which identifies financial benefitsto some environmental initiatives is to be believed (Reinhardt, 1999;Porter and Van der Linde, 1995), and there is no significant positive ornegative correlation found in this study between corporate environmentalgovernance and financial performance, then it is justifiable to conclude thatthere are other more significant influences on financial performance that




render overall environmental governance commitment negligible in termsof influencing financial performance.

5. Conclusion

From an environmental conservation perspective, it would have beenheart-warming to conclude from the research undertaken in this studythat a firm’s commitment to environmental governance is positively andsignificantly correlated to financial performance. Clearly, if such a positivecorrelation did exist, a rational profit-maximizing firm would be negligent inits duties if it did not adopt enhanced environmental governance strategies.Proving that such a correlation exists could catalyze a new era of corporateenvironmental benevolence. However, the research presented in this paperindicates that such an absolute correlation likely does not exist. In allprobability, any positive influence of environmental governance on financialperformance is overpowered by other variables that influence financialperformance.

This conclusion is in itself a useful contribution to the study ofenvironmental governance policy. If it is a goal of environmental governancepolicy to promote improved corporate environmental governance practices,then policy makers must understand the realities which impinge upon thisoutcome.

With no significant correlation between environmental commitmentand financial performance, a profit-maximizing firm can at best beexpected to generally adopt satisficing environmental governance strategies(Doyle, 2003). Profit maximizing firms will seek to: (1) implementenvironmental initiatives that are profitable, (2) comply with regulationsgoverning unprofitable areas of environmental governance and (3) satisficestakeholders groups to defend against unwanted stakeholder protest.

If policy makers are to successfully develop policies to motivateimproved corporate environmental governance, they need to make the effortto understand the realities underpinning the challenges that corporateleaders face. Policy makers need to understand that the vast majority ofcorporate leaders do not get up in the morning with the intent of carryingout policies to erode the planet’s environmental capital. The vast majorityof corporate leaders get up each morning with the knowledge that they mustsatisfy the profit expectations of their owners and the broad needs of variousinternal and external stakeholders. In other words, each day, managementperforms a precarious balancing act. True there are some corporate leaders




that neglect environmental issues because they do not see environmentalproblems as part of the corporate remit. However, the majority of businesspeople likely seek balance if only to reduce the risk of civil reprisal againstpoor environmental governance.

As the discussion leading to the development of the SEM Frameworkdemonstrated, there are a number of justifiable business reasons to improveenvironmental governance. There are also a number of endogenous andexogenous forces that catalyze better corporate environmental governance.Until change comes to the economic, free market, capitalistic structure thatguides corporate activities in most countries around the world, corporateleaders will continue to pursue profit-maximization within the limitsprescribed by legislation, regulation, and stakeholder pressure. Withinsuch bounded rationality, sustainable environmental management practicesare unlikely to be attainable. Accordingly, rather than trying to changemindsets by appealing to the social consciences of corporate leaders, policymakers should be trying to change the structural flaws that give rise to thisdilemma. In the short run, this may imply more regulatory control overenvironmental governance.

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